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Draghi Keeps Gradual Recovery Faith as ECB Cuts Forecasts

Matthew Brockett and Jeff Black

March 7, 2013, 10:35 AM EST

European Central Bank President Mario Draghi stuck to his view that the euro region will gradually recover later this year even as officials trimmed their economic forecasts and considered cutting interest rates.

“Later in 2013 economic activity should gradually recover, supported by a strengthening global backdrop and our accommodative monetary policy stance,” Draghi told a press conference in Frankfurt after the ECB left its benchmark interest rate at 0.75 percent, a record low. While officials discussed cutting borrowing costs today, the “prevailing consensus was to leave the rates unchanged,” Draghi said.

Uncertainty caused by the stalemate in last month’s Italian election, where anti-austerity parties won more than half the vote, has renewed concern that the euro area may struggle to overcome the sovereign debt crisis and exit recession.

The ECB today predicted the 17-nation economy will shrink 0.5 percent this year, more than the 0.3 percent contraction forecast three months ago. The estimate for 2014 growth was reduced to 1 percent from 1.2 percent. The central bank also cut its 2014 inflation projection to 1.3 percent from 1.4 percent. It aims to keep inflation just below 2 percent.

High Bar

The inflation outlook is “broadly balanced,” Draghi said, even though the risks to the economy are on the downside.

“The ECB is now projecting lower growth than any other institution and has lowered the inflation projection for 2014,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt. “The fact that it still decided against a rate cut underscores that the bar is higher than many assume.”

The euro climbed as Draghi spoke and traded at $1.3096 at 4 p.m. in Frankfurt compared with $1.3020 beforehand. While the euro has risen 8 percent since July, it has dropped about 4 percent since the start of February.

The central bank’s new forecasts assumed an exchange rate of $1.35 for this year and next.

The ECB president omitted from his opening remarks a statement made last month that the euro’s appreciation posed a downside risk to inflation. The exchange rate is broadly in line with its long-term averages, he said later.

Earlier, the Bank of England held its bond-purchase program at 375 billion pounds ($565 billion) and kept its key rate at 0.5 percent.

Berlusconi’s Return

Italian bond yields jumped after anti-austerity parties led by former Prime Minister Silvio Berlusconi and comedian-turned-politican Beppe Grillo won about 55 percent of the vote in last month’s election. That triggered fears of a new wave of market turmoil across the euro region that would send borrowing costs surging from Rome to Madrid and Dublin.

“Markets understand that we live in democracies,” Draghi said, adding that overall, confidence is returning to the euro area. “Fragmentation is not worsening it’s actually improving, it’s receding” and the recovery path is “largely unchanged,” he said.

The yield on Italy’s 10-year bond dropped to 4.62 percent today from 4.9 percent on Feb. 26. Spain’s 10-year yield has declined to 4.90 percent from 5.37 percent in the same period.

Concerns that record-low rates aren’t being properly transmitted in some nations has stoked speculation that the ECB may introduce additional measures to encourage bank lending to small and medium-sized companies.

“We always think and study and reflect, but we are not committing to or planning anything special,” Draghi said, adding the ECB’s monetary policy “will remain accommodative for as long as needed.”

“Draghi remains dovish,” said Anders Svendsen, an economist at Nordea Bank AB in Copenhagen. “But more weakness is needed to make the ECB cut rates.”

(Updates with analyst’s comment in fifth paragraph. For more on Europe’s debt crisis, see TOP CRIS.)